Reference no: EM131412428

Assignment: The Buy vs. Rent Decision

Currently Jackie is renting a two-bedroom condominium in Los Angeles for $3,450 per month. Virtually an identical unit next door became available for sale with an asking price of $620,000, but Jackie believes she could purchase it for $600,000. While Jackie really liked the condominium unit she was renting, as well as the condominium building itself, she felt that it would be inadequate for her long-term needs, as she planned to move to a house or even to a larger penthouse condominium within five to 10 years - even sooner if her job continued to work out well.

If Jackie purchased the condominium unit, she would pay monthly condo fees of $1,300 per month, plus property taxes of $500 per month. Unlike when renting, she would also be responsible for repairs and general maintenance, which she estimated would average $50 per month. If she decided to purchase the unit, Jackie intended to provide a cash down payment of 20% of the purchase price.

There were also closing costs along with other related costs to purchasing the condo that totaled $20,000. For simplicity, other than a monthly property tax of $500, Jackie planned to ignore any tax considerations throughout her analysis.

To finance the remaining 80% of the purchase price, Jackie contacted several lenders and found that she could lock-in a 30 year 4.10% fixed-rate mortgage where she would be required to make monthly payments (4.10% is the nominal annual rate). The money that Jackie was planning to use for her down payment and closing costs was presently invested and earning the same monthly rate of return as she would be paying on her mortgage. Jackie assumed that if she were to sell the unit, she would pay 6% of the selling price to the realtor in fees.

Tasks:

1. If Jackie purchases the condominium, compute her required monthly mortgage payments (assuming end of month payments). Construct a Loan Amortization Schedule for Jackie and determine how much Jackie will still owe on her loan after 5, 10 and 15 years.

2. If Jackie were able to divide the monthly payments into two equal amounts and make fortnightly payments instead (i.e., 26 payments a year), compute how long it would take her to repay the loan and how much interest she would save (on an undiscounted basis).

3. Compute Jackie's opportunity cost (on a monthly basis) of using the lump-sum required funds for the condominium purchase rather than leaving those funds invested and earning the monthly rate (assumed to be equivalent to the monthly mortgage rate). Compute the additional monthly payments required to buy the condominium compared to renting (include the opportunity cost in your computation).

4. If the condo price increases at the expected rate of inflation of 2% per year over the next five years, compute the present value (i.e., at time 0) of her net gain/loss assuming she were to sell the unit after five years rather than continuing to rent. Recompute the present value assuming she sells after 10 years and then assuming she sells after 15 years.

5. List some computations or valuation assumptions that Jackie should consider (there is no need to do the computations, just state some plausible alternative scenarios that Jackie ought to consider).

6. List some qualitative factors that Jackie might want to consider in the buy vs. rent decision (an example might be that buying creates a "forced savings" plan).